Silicon Valley is stupid (which is why it works)

Be Stupid_ Some rights reserved by Michiel020

In the past year, I have met with startup founders and government officials around the world. Everywhere I go, people are hungry to know how they can be clever like Silicon Valley. They assume that since I founded PBworks, a private wiki host and home to over two million groups, I must have insight into the smarts that make the Valley work, and they want to implement those good ideas in their regions.

But Silicon Valley works because it is stupid. The intelligence is distributed, and the ultimate arbiter of correctness is the market.

Let’s start with the startups. You might think that most successful startups begin with some genius’s brilliant idea. The genius shares this idea with a trusted investor who provides money to hire a team. They work really hard, have a big launch and become a success. But this is not how big companies begin. Companies that start this way tend to be good at spending a lot of money and producing useless products.

Successful startups often begin with no idea at all. They start with some friends who simply enjoy building things together, without any specific idea of what they are going to build or how they are going to make money at it. It sounds silly, but that’s exactly how Hewlett-Packard began. Two nerds in a garage. It took them a few years to find their first really good idea, which was to make cheap, high-quality oscilloscopes. Flickr began by working on something else altogether. Twitter came out of the train wreck of a podcasting startup. If a good team goes through enough ideas, they will eventually figure out how to make something that people want to use. Then, they raise money to bring that product to more people and scale it up.

Okay, so startups are dumb, but what about governments? It’s not that hard to believe that governments are dumb. What’s surprising is when that’s a good thing. The U.S. government is not smart enough to pick winners, so startups are treated like regular companies. When I first traveled to Mexico, I was asked whether the U.S. government paid for all or only part of our office space. The entrepreneurs were astonished to find out that my startup got no help whatsoever from the government. We were on our own. Terrifying. In theory, the Small Business Administration is there to help, but it is irrelevant to startups. It’s structured to help a dry cleaning shop purchase another piece of equipment, not help you hire another iOS developer so you can create Angrier Birds.

But what the U.S. government does do is get the heck out of our way. If you want to start a business, you can just go ahead and do it with no forms at all required. This is called a “sole proprietorship.” At the end of the year when you fill out your personal income taxes, you just attach an appendix that says, “Oh yeah, and I run a business and here’s how much money I made or lost.” If you want to incorporate your business, you can do it in about an hour. The form to create a tax ID takes a minute or two to fill out. Dozens of companies compete to offer cheap and easy payroll tax processing that electronically file everything you need with the state and federal governments for a few bucks a month. The government’s role is infrastructure and facilitation.

If government gave special aid to startups, it would need to ensure those startups were performing well, which would require startups to account for their progress or face punishment for wasting taxpayer money. This regular accounting smells like added paperwork. And overhead. Worst of all, it means bureaucrats are making the call about which startups stay and which go. And when bureaucrats have no incentive to pick longterm winners, they might be persuaded to be more lenient to startups that have friends in high places.

Startups funded by a government cannot, politically, afford to fail. But the real way to create new markets is to do the opposite — reduce the cost of failure by eliminating debtors’ prisons, make bankruptcy straightforward, and allow easy incorporation to shield founders’ personal finances somewhat from the failure of their companies. Even success takes too long for governments. Government programs are managed for the next election cycle, while startups usually take much longer than that to be proven out as a success.

So it’s actually much better if government is “stupid” and delegates the intelligence about which startups should thrive and which should die to others. The government should ensure clear and consistent corporate law and taxation, minimal red tape and overhead, fast and effective infrastructure, easy hiring and firing, and should expose itself as a customer of startup products.

The final dumb contingent of Silicon Valley is our awesome, dumb investors.

In many developing ecosystems, I see angels who describe themselves as “smart money.” They want to take 40 percent or more of the company in a seed round to ensure that the entrepreneur does the right thing, and that if the company is successful, the investor benefits richly. They think they will guide the company to success. They want to have a voice in the day-to-day operations of the company, and when they speak, they expect their entrepreneurs to listen.

But investors who take 40 percent of the company in seed rounds are setting themselves up for failure. If the company does well, it’ll need to raise more financing, and new investors will need substantial percentages of the company. With IPOs taking longer than ever, there may be many of these growth rounds. And if 40 percent of the company is in the hands of a seed investor, there’s not enough room for other investors. A Series A venture capitalist will realize this and simply not invest in a company with this kind of structure, meaning the company will not be able to find financing, even if it is very successful. The “smart” seed investor has effectively doomed the company.

Peter Thiel was the first investor in Facebook. He wrote a check for $500,000 and got a board seat and about 10 percent of the company (not 40 percent), but mostly he just told Zuckerberg to not f**k it up. When the company IPOed years later, poor Peter was left with a mere 2.5 percent stake of the company. But I don’t think he was too upset, because that stake was worth a billion dollars, which makes it the most successful seed investment in history. All for just believing in a smart kid and letting him do his thing. Peter was, brilliantly, not “smart money.”

So the best government defers smarts about which startups to invest in to the investors, the investors defer smarts about how to build the company to the startups, and startups defer the wisdom of what would be a good idea to build to the market. The intelligence is distributed, and it works.

David Weekly is the CEO of Oha.na, which helps users create visual newsletters. He is also a startup mentor and has helped found Hacker Dojo, PBworks, Mexican.VC and SuperHappyDevHouse.

Image courtesy of Flickr user Michiel020.  

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